Chapter 7 Small Business Bankruptcy

Chapter 7 bankruptcy is a liquidation bankruptcy.  It’s for the going-out-of-business situation, where there is no hope of saving the business.  A small business bankruptcy is not filed very often.

The first question that comes to mind is whether a small business bankruptcy should file Chapter 7, or the owner file Chapter 7, or both file Chapter 7.  This depends partly on the entity status of the business.  Is the business is formed as a corporation, a partnership, or a limited liability company?  Or, is the business not formed as a separate entity but rather a sole-proprietorship, i.e., merely an extension of the owner (usually indicated by the owner filing a schedule C on his or her 1040 tax return)?  If the business is a sole-proprietorship, the owner must file Chapter 7.

All of these separate entities may file Chapter 7 independent of the owner.  However, the owner is most likely going to have to file Chapter 7 also because the owner usually has guaranteed business obligations, like rent and accounts with suppliers.  In that case, there may be no reason to file Chapter 7 at the entity level.  Instead, the business just shuts down and the owner files bankruptcy.

Corporations and other entities can file Chapter 7 but they do not get the benefit of having debts discharged, so there’s not much reason to file bankruptcy unless an orderly winding down of the business is needed.  The bankruptcy trustee directs the business closure at no expense to the owner(s).  Creditors are paid from business assets in accordance with a priority system imposed by bankruptcy law.

If the ambition is to save the business, then a Chapter 13 or Chapter 11 may be advisable if the business is a sole-proprietorship.  If the business is not a sole-proprietorship, that is to say it is a corporation or such, a Chapter 11 may be advised (a reorganization).  A Chapter 11 is very complex and accordingly very expensive.  Even a Chapter 13 is more complex and expensive than a Chapter 7. Most Chapter 11s fails for lack of a real means of saving the business, and many Chapter 13s also fail because the debtor cannot stay on the payment plan approved by the court.

Where the business requires few assets and the business is merely an extension of the owner, it might be advisable to file a Chapter 7 and start over again, with or without a new entity.  This is frequently faster and easier than a Chapter 13 or 11.